(a) Eligibility and operational criteria for double default treatment. A Board-regulated institution may recognize the credit risk mitigation
benefits of a guarantee or credit derivative covering an exposure
described in section 217.134(a)(1) by applying the double default
treatment in this section if all the following criteria are satisfied:
(1) The hedged exposure is
fully covered or covered on a pro rata basis by:
(i) An
eligible guarantee issued by an eligible double default guarantor;
or
(ii) An eligible
credit derivative that meets the requirements of section 217.134(b)(2)
and that is issued by an eligible double default guarantor.
(2) The guarantee or credit
derivative is:
(i) An uncollateralized guarantee or
uncollateralized credit derivative (for example, a credit default
swap) that provides protection with respect to a single reference
obligor; or
(ii)
An nth-to-default credit derivative (subject to the requirements
of section 217.142(m).
(3) The hedged exposure is a wholesale
exposure (other than a sovereign exposure).
(4) The obligor of the hedged exposure
is not:
(i) An eligible double default guarantor
or an affiliate of an eligible double default guarantor; or
(ii) An affiliate of the
guarantor.
(5) The Board-regulated institution does not recognize any credit
risk mitigation benefits of the guarantee or credit derivative for
the hedged exposure other than through application of the double default
treatment as provided in this section.
(6) The Board-regulated institution has
implemented a process (which has received the prior, written approval
of the Board) to detect excessive correlation between the creditworthiness
of the obligor of the hedged exposure and the protection provider.
If excessive correlation is present, the Board-regulated institution
may not use the double default treatment for the hedged exposure.
(b) Full coverage. If a transaction meets the criteria in paragraph (a) of this section
and the protection amount (P) of the guarantee or credit derivative
is at least equal to the EAD of the hedged exposure, the Board-regulated
institution may determine its risk-weighted asset amount for the hedged
exposure under paragraph (e) of this section.
(c) Partial coverage. If a transaction meets
the criteria in paragraph (a) of this section and the protection amount
(P) of the guarantee or credit derivative is less than the EAD of
the hedged exposure, the Board-regulated institution must treat the
hedged exposure as two separate exposures (protected and unprotected)
in order to recognize double default treatment on the protected portion
of the exposure:
(1) For the protected exposure, the Board-regulated
institution must set EAD equal to P and calculate its risk-weighted
asset amount as provided in paragraph (e) of this section; and
(2) For the unprotected
exposure, the Board-regulated institution must set EAD equal to the
EAD of the original exposure minus P and then calculate its risk-weighted
asset amount as provided in section 217.131.
(d) Mismatches. For any
hedged exposure to which a Board-regulated institution applies double
default treatment under this part, the Board-regulated institution
must make applicable adjustments to the protection amount as required
in section 217.134(d), (e), and (f).
(e) The double default dollar risk-based capital
requirement. The dollar risk-based capital requirement for a
hedged exposure to which a Board-regulated institution has applied
double default treatment is KDD multiplied by the EAD of
the exposure. KDD is calculated according to the following
formula: KDD = Ko × (0.15 + 160 × PDg), where:
(1)
Figure 1. DISPLAY EQUATION
$$
K_O = LGD_g \times
\Bigg[ N \Bigg \lgroup \frac{N^{-1}(PD_o) + N^{-1}(0.999)\sqrt{\rho_{os}}}{\sqrt{1-\rho_{os}}} \Bigg \rgroup - PD_o \Bigg]
\times
\bigg[ \frac{1 + (M - 2.5) \times b}{1-1.5 \times b} \bigg]
$$
(2) PDg = PD of the protection
provider.
(3) PDo = PD of the obligor of the hedged exposure.
(4) LGDg =
(i) The lower
of the LGD of the hedged exposure (not adjusted to reflect the guarantee
or credit derivative) and the LGD of the guarantee or credit derivative,
if the guarantee or credit derivative provides the Board-regulated
institution with the option to receive immediate payout on triggering
the protection; or
(ii) The LGD of the guarantee or credit derivative, if the guarantee
or credit derivative does not provide the Board-regulated institution
with the option to receive immediate payout on triggering the protection;
and
(5)
ρos (asset value correlation of the obligor) is calculated
according to the appropriate formula for (R) provided in Table 1 in
section 217.131, with PD equal to PDo.
(6) b (maturity adjustment coefficient)
is calculated according to the formula for b provided in Table 1 in
section 217.131, with PD equal to the lesser of PDo and
PDg; and
(7) M (maturity) is the effective maturity of the guarantee or credit
derivative, which may not be less than one year or greater than five
years.
